Why income stocks may be risky

Market Realist

Overview: Why investors should watch for asset class deception (Part 2 of 5)

(Continued from Part 1)

Certain income stocks are looking expensive. When it comes to generating income with stocks, many investors have pursued equity sectors that may offer high dividend yields and potentially less price swings than the overall market. Think real estate, telecoms, utilities and consumer staples.

But while many bond proxies, such as utilities and real estate, have outperformed in 2014 given the renewed move lower in interest rates, these historically higher dividend yielding sectors have under-performed the overall market since 2011 amid improving economic activity.

Market Realist – There has been a shift to real estate (VNQ), utilities (XLU), and consumer staple (XLP) stocks in 2014 because investors are looking for equities with bond like characteristics that give them a higher income. In particular, the performance of real estate and utilities is impressive with year-to-date (or YTD) returns of 18.32% and 14.37%, respectively. In contrast, the overall market returns as tracked by iShares Core S&P 500 ETF (IVV) stand relatively low at 8.17% YTD. It’s important to note that although these sectors have outperformed the overall market in 2014, if we look at their one-year, three-year, and five-year returns in comparison to the overall market, they have under-performed significantly. The previous graph compares the performance in terms percentage of returns for varying time periods for the iShares U.S. Real Estate ETF (IYR), the iShares U.S. Utilities ETF (IDU), and the Core S&P 500 ETF (IVV).

In addition, while some of the valuation premium of the bond proxy equity sectors has come off in recent years, they are still somewhat expensive relative to recent history. For example, relative price-to-forward earnings ratios for utilities are at the upper end of their historical range.

Market Realist — Continue reading the next part of the series to learn how riskier bonds and seeking income at all costs can be hazardous to your portfolio.

Continue to Part 3

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